A Foundation for the Economy to Build On

January 04, 2001

By Christopher Farrell The new year started off miserably. The Nasdaq continued to plunge, with the tech-laden index down some 55% from its Mar. 10 record high. Manufacturers revealed they were working at their slowest pace since the end of the 1991 recession. Gloomy Wall Street money mavens and worried Bush Administration officials-to-be warned that the economy was fast sinking into a recession.

The Federal Reserve Board decided to break the dark mood with an unexpected half-point slash in the federal funds rate on Jan. 3. Cheered investors sent stock prices soaring on the reasonable expectation that lower interest rates will help prop up a staggering economy. This is especially important with regard to the highly interest-rate-sensitive residential housing market. "The 2001 housing market will be one of the sectors of the economy helping to hold off a recession," says David Berson, chief economist at Fannie Mae.

Clearly, low mortgage rates are supporting that market. The 30-year fixed conventional mortgage rate has dropped nearly a percentage point over the past year, to 7.1%. That could easily slip to 6.75% in coming months if the Fed eases several more times, which seems likely. Home sales will stay healthy on lower mortgage rates, and housing starts should remain relatively stable. "Housing will be a bright spot in the first half of the year in the sense it might not be declining," says Joel Prakken, a founder and principal at Macroeconomic Advisors Inc., an economic consulting firm based in St. Louis.

REVERSAL. Ironically, it's the residential housing market that typically leads the economy into a recession. Take the onset of the last downturn, in 1991. Back then, housing starts plunged as already painfully high mortgage rates edged up to 9.95% in the final quarter of 1990 from 9.82% in the last quarter of 1989, according to John Lonski, economist at Moody's Investor Services in New York. The situation worsened as the rate peaked at 10.48% in May, 1990.

But this cycle appears to be playing out differently. Consumer balance sheets and spending plans will get a boost from this week's rate decline. Applications for mortgage refinancing are running at more than double the pace of six months ago, according to the Mortgage Bankers Association of America. And thanks to home prices increasing 4% to 5% annually in recent years, homeowners have built up adequate equity cushions. "People have the wherewithal to free up some cash by tapping into their equity," says Doug Duncan, chief economist at the MBAA.

Demographics also will benefit the housing market in 2001. The 2000 Census indicates that population growth was underestimated over the past decade. For instance, the latest numbers suggest that America's population expanded at a 1.2% average annual rate, rather than the previous annual estimate of 1%. In a nation of nearly 300 million people, such a minor discrepancy adds up to some big numbers. The gap stems from undercounting immigrants.

PUTTING DOWN ROOTS. Although immigrants contributed a healthy 15% of the net growth in home ownership in recent years, the overall home-ownership rate among the foreign-born is only now beginning to rise, according to Harvard University's Joint Center for Housing Studies. The reason is that newcomers often can't afford to purchase a home right away, at first, but home buying will increase as longer-term immigrants make up a greater share of the nation's foreign-born population. "Every study has noticed that the longer an immigrant lives in the U.S., the greater the propensity to buy a home," says Berson of Fannie Mae.

Many investors and analysts are convinced that the recent bloodbath on Wall Street signaled a recession. Lower stock prices would crush consumer demand and confidence. It's true that more than half of all U.S. households own stock either directly or through a mutual fund. But the positive impact of the home as an asset on consumer attitudes and balance sheets has been neglected. The home-ownership rate reached a record 67.7% in the third quarter of 2000. A stable housing market, coupled with a recession-fighting Fed, just might rejuvenate a flagging economy. Farrell is contributing economics editor for Business Week. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online